Lexmark: LBO at $60-$70 A Share Looks Doable

Lexmark (LXK) would make a good LBO candidate. And in fact, it already was one, back in 1991, when it was spun off from IBM (IBM) with the private equity firm Clayton, Dubilier & Rice. The company then came public in 1995.

Bernstein Research analyst Toni Sacconaghi Friday morning considers when another LBO would make sense, and concludes that it would - although he sees some potential stumbling blocks.

“From a valuation perspective, LXK screens very attractively as an LBO candidate on several metrics,” Sacconaghi finds. He says it's in the cheapest decile in the S&P 500 based on trailing EV/EBITDA, and he believes the valuation is “significantly” more attractive at 6.1x trailing EBITDA, or 6.8x 2007 EBITDA, than other recently announced tech LBOs, including Avaya (AV), Affiliated Computer Services (ACS), First Data (FDC) and Alltel (AT), which were at 9x EBITDA or higher.

He also notes that the company’s operating expense ratio is at the highest level since 1998, “potentially providing a material opportunity for enhancing operations margins and cash flows.”

Sacconaghi says a buyout at $70 a share is “financially doable,” as a 200 basis point cut in operating expenses could boost free cash flow by $80 million a year. He says a $70 takeout could work for an acquisition funded 85% with debt.

On the other hand, he says the risk profile for Lexmark is higher than with other LBOs, which could provide private equity firms a reason to hesitate before pulling the trigger. Reducing operating expense could undermine the company’s ability to grow, he says. The analyst notes that Lexmark is trying to improve its inkjet business by abandoning low end offerings and moving upmarket. The repositioning, he says, has triggered the increase in operating expenses. He cautions that “a hasty reduction in OpEx could undermine the company’s growth initiatives and relegate LXK to limited to no revenue growth going forward.”

He also cautions that the laser business “appears to be getting tougher,” with margins down from 20% at the end of 2004 to 13% in the first quarter of this year. Sacconaghi also notes that the company faces risks to its inkjet business from Kodak (EK) and Memjet. He says Lexmark “is trying to reposition its brand to enable it to sell at better ASPs, which may or may not be successful.”

Sacconaghi says profitability in the company’s inkjet business has rebounded; he says “a full closure of the business to milk supplies no longer appears to create significant value vs. keeping the business.”

Despite the caveats, he concludes that a buyout in the $60-$70 range is “doable.” He rates the stock Market Perform, with a $54 price target, and says he would get more interested in the shares under $50.

LXK 1-yr chart: